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Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364

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BuyFindarrow_forward

Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364
Textbook Problem

List some advantages and disadvantages of the different exchange rate policies.

To determine

The Pros and cons of different exchange rate policies are to be determined.

Explanation

Following are the different regimes of exchange rate:

  1. Floating exchange rate system
  2. Soft peg
  3. Hard peg
  4. Merged currencies

The advantages and disadvantages of different exchange rate regimes are explained as follows:

  1. Floating Exchange rate system: Floating exchange rate system is the currency regime where the exchange rate can be determined by the market forces of demandand supply of a currency. In this case, the central bank’s intervention in the exchange rate determination is minimal. Under floating exchange rate system, the exchange rate is more likely to have short-term and long-term fluctuations. The flexibility of exchange rate makes the central bank more powerful as it is free to use its monetary policy to influence output and prices in the economy. However, there is no control on the inflow or outflow of foreign exchange reserves. In addition to this, since in case of floating exchange rate system the exchange rate is determined freely by the market forces, the imbalances in trade are automatically corrected by inflow or outflow of funds.
  2. Soft peg: Soft peg is the policy of exchange rate where the central bank lets market forces of demand and supply determine the exchange rate, however, the central bank intervenes if the exchange rate moves irrationally in either direction. Short term exchange rate fluctuations undersoft peg are less. However, long term exchange rate fluctuations can happen. It is likely that contradictions between exchange rate policy and counter-cyclical monetary policy arise since the central bank loses some power over monetary policy because of intervening in the exchange rate determination...

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